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How do first- and third-party special needs trusts differ?

When your child has a disability, you may need to take extra estate planning steps to make sure any assets you leave behind do not make your child ineligible for government help. Many California parents of children who have special needs establish special needs trusts. These trusts enable you to set aside funds for your child to use after your death without those funds hurting government assistance eligibility. 

Per the Special Needs Alliance, special needs trusts come in two types. The first is the first-party special needs trust. The second is the third-party special needs trust. 

First-party special needs trusts

If your child with special needs inherits money or property or secures a settlement, a first-party special needs trust may make sense. Aside from how they undergo funding, a first-party special needs trust also differs from a third-party special needs trust in terms of what happens to the funds inside when the beneficiary dies. With a first-party trust, any remaining funds must go toward Medicaid reimbursement. 

Third-party special needs trusts

A third-party special needs trust may meet your needs if you are making a plan ahead of time to preserve your child’s public assistance eligibility. Funding for a third-party trust comes from someone or something other than the beneficiary. So, the funds in the trust do not come into play during means-testing for government assistance. Any remaining funds in this type of trust do not have to go toward Medicaid reimbursement, either, giving you more control over where they end up. 

Keep in mind, too, that there are tax implications associated with creating either type of special needs trust.